I donâ€™t know why, maybe because those â€œforex coachesâ€ like to make money off newbie traders, but for some reason with most things in forex the simplest of things are turned into insurmountably complex ideas and theories that leave people frustrated and confused instead of educated and empowered. And never has this been more true than in the case of Fibonacci Levels. More literature and debate has gone into this area than most of the other 1,001 indicators, and more â€œexpertsâ€ use them to baffle and confuse traders than any other indicator. But it only shows that these lines are hugely popular and important to trading success. And I am about to give you a very simple lesson on how to use them.
Why are Fibonacci Levels so important?
Just as support/resistance and pivot point lines work so well because big banks and thousands of successful traders use them in their trading strategy each and everyday, the same goes for fib levels. It becomes a self-fulfilling prophecy when so many people see the same things and interpret them in similar ways. They work on any timeframe and with any commodity (oil, gold, stocks, futures, etc.).
Traders use these lines for two crucial reasons:
They are great at predicting where a retracement will likely end and they are great at predicting where the price action will continue towards once the retracement period had ended. So in other words fib.levels tell you where you can jump back into a major trend when a currency pair starts retracing and where to take profits on that same trade once the pair resumes in the direction of the main trend.
How do fib lines do this?
Continuing along with the above two points, you can think of fib. levels as having two distinct functions: retracement levels and extension levels. One tells you key levels to watch for support/resistance during a retracement, the other tells you where you should set your T/P once the trend resumes its original course. Hereâ€™s a pic that shows how I used fib. lines to predict where the EUR/USD was headed after a brief retracement period.
But you donâ€™t have to use them in-conjunction with each other. What I mean is that I use the retracement levels the most for predicting price levels worth re-entering in the direction of the main trend. Once I see a major trend has begun, I wait for a reversal in price action to take place (retracement), throw my retracement levels up on the charts, and then wait to see when price action meets resistance/support at a key fib level such as the 61.8 or the 50, and thatâ€™s where I re-enter.
How to draw fib levels
So letâ€™s go over what that pic showed you. First in order to draw your retracement and extension lines you need a swing high and swing low point (points A and B in the picture). Now thereâ€™s no science behind picking these two points because everyone interprets their own charts a little differently, so you try to get as close as possible to what everyone else sees. How do you do that? One good method is to look for long wicks on the candle sticks because that usually indicates that a reversal is in the making.
Once you can clearly see that price action is in a true retracement you wait and see at what level does the price action encounters support (in a up trend) or resistance (in a down trend). Usually that level corresponds to the 38.2, 50, or the 61.8 retracement levels. Aggressive traders will jump into a position right at each one of those levels with their S/L 10 pips above it, then if that didnâ€™t work out and price continues to the next retracement level, they will jump back in again. This explains why price action appears to be in a tug-of-war at certain times. At some point the retracement period will end and then price action will continue back in the direction of the trend and those aggressive traders will make up for lost pips.
A conservative trader, like myself, will just wait and see where price action actually did finish retracing, and then jump in a little late but safer and with
less stress, still knowing where the trend should meet support/resistance again based on the extension levels. I would rather go for 80% of the safe pips than try and snatch up the 10% to 20% of the pips that I miss out on through waiting. Remember in trading itâ€™s not about how much you make, its how much you make AND can hold onto in the long run.
Rules for success when using fib lines
So what are the rules for where price action will go once we see its finished retracing and back to trending in the original direction again? Again, this is not an exact science here so you donâ€™t want to just place your T/P right on one of these lines, as prices may not quite reach the line, since other traders are interpreting their own fib lines and acting accordingly too. But in general the rules go:
23.6 will continue on to 118 or 127
38.2 will continue on to 138.2
50 will continue on to somewhere in between 138.2 and 161.8 (use other indicators to know where)
61.8 will go to 161.8.
The big ones to always watch for are the 38.2, 50, and 61.8 retracement levels and their corresponding extension levels. Iâ€™d say about 75% of the time those levels are the ones that end up being hit.
Setting this up in MT4
So the last thing I need to do is tell you how to draw these lines within your MT4 platform. Sorry for those of you who use other platforms, but you still learned the bulk of the lesson. Now for certain reasons, MT4 designed their platform to have two separate fib tools, one for retracements and one for extensions. But as I just showed you, both of them are used in conjunction with the other, so I just combined them into the retracement tool so that I donâ€™t have to draw the lines separately. Hereâ€™s how to do it.
Place a fib retracement on your graph (itâ€™s the 7th button from the lower left row of your chart toolbars in MT4). Then go to Charts, then Objects, and then click on Objects List where you will see the â€œfibo lineâ€ as itâ€™s listed as. Highlight it by clicking on it once, and then click on edit to your right. Once in there you can input levels of your own. Input the levels in this order: 0.0, 23.6, 38.2, 50, 61.8, 78.6, 86, 100, 127, 138.2, 161.8, 261.8, 423.6. And in order to see the price at each fib level, click the Fibo level tab, then type next to the numbers in the description, %$. This will give you the corresponding price for each level you have selected.
Now whenever you go to draw a fib retracement youâ€™ll have both the retracement lines and the extension lines drawn simultaneously!
Thereâ€™s two more points I have to address here. The first is the â€œbonusâ€ levels of 261.8 and 423.6. Youâ€™ll see these levels reached sometimes when applying fibâ€™s on the lower timeframes and they are bonus rounds you could say for an extension. The rules you follow to know if the bonus round will happen is if you see the 161.8 level broken AND then retested as support/resistance AND it holds up as such. In that case your likely going to see the 261.8 target hit and if that holds up as support/resistance you can expect 423.6 to be reached. Lock in profits behind the 161.8 line just to be safe.
The second rule, and this is a real crucial one, is that fibâ€™s are ALWAYS to be used in conjunction with other indicators. They are not a standalone kind of thing where you can base your decisions exclusively on these lines. You should have moving averages telling you what the main trend is doing, your own support/resistance lines as well as pivot points confirming retracement and extension levels, and whatever other indicators you specifically rely on to make decisions.
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